Friday, September 25, 2015

A curious thing happened to me this morning. As I was walking through the hallway of my apartment building, I noticed that the door to a neighbour's apartment was open. I glanced into the apartment as I passed, and was struck by how different the apartment looked to mine. Despite having similar layouts, the two apartments were (unsurprisingly) furnished and arranged differently. None of this should have come as a surprise to me, but it was still jarring to see an apartment different from the model I had created in my head.

What do these two incidents have in common? In both instances, the people involved appeared to suffer from a distinct lack of imagination, or perhaps an overly narrow perspective. For investors, this flaw can be harmful. Renowned macro trader Bruce Kovner said, "I have the ability to imagine configurations of the world different from today and really believe it can happen." He believed this was an important element of his success.

Sanjay Bakshi refers to a similar concept, which he calls empathy. In a talk entitled "The Prejudices of Mr. Market", he touts empathy as a way for investors to better understand the customers, competitors and executives of businesses they own, as well as other financial market participants.

This comes as a time when empathy, in its more traditional sense, is making a resurgence as a valued skill. Summarizing his new book, "Humans Are Underrated", Geoff Colvin writes, "The evidence is clear that the most effective groups are those whose members most strongly possess the most essentially, deeply human abilities - empathy above all, social sensitivity, storytelling, collaborating, solving problems together, building relationships."

Many fund managers deliberately avoid excessive contact with their underlying investors. There's no doubt that it can be detrimental to a manager's sang-froid (and a drain on scarce time) to be constantly reacting to investors' concerns about volatility in financial markets. Yet at the same time, it's worth remembering that fund managers serve not only to invest wisely, but to shepherd their investors through turbulent times. This involves understanding investors' concerns while effectively communicating a long-term strategy. It seems clear that investment managers who can harness technology - or "race with machines", to quote Brynjolfsson and McAfee, will outperform those who try in vain to race against machines. But the human element of investment management - empathy, communication and leadership - will remain every bit as important. Fund managers will do well to nurture these skills to become better analysts as well as more valuable guides on the treacherous path that is investing.

Sunday, September 6, 2015

In order to become a Buddhist, one is encouraged to embrace (and "take refuge in") the "Three Jewels", a set of ideals that anchor the individual. The jewels are (1) the Buddha, (2) the Dharma, and (3) the Sangha. The Buddhist Centre describes the Three Jewels more fully as follows:(1) "Going for Refuge to the Buddha means seeing him as your ultimate teacher and spiritual example. It also means committing yourself to achieving Buddhahood...which means that you aim to become someone who sees the nature of reality absolutely clearly, just as it is, and lives fully and naturally in accordance with that vision."(2) "The Dharma primarily means the teachings of the Buddha, or the truth he understood. The word 'Dharma' has many meanings but most importantly it means the unmediated Truth (as experienced by the Enlightened mind)... Regarding the Dharma as a refuge means seeing these teachings as the best guide to reality, and committing yourself to practicing them."(3) "If we are to practice the Dharma we need the example and teaching of others who have done so before us, especially those who have gained insight into the nature of reality themselves. So the third of the Three Jewels is the Sangha or the spiritual community... We need the guidance of personal teachers who are further along the path than we are, and the support and friendship of other practitioners."I have recently completed a slew of value investing-oriented books, and have been thinking about whether we can formulate a similar Three Jewels of Investing. You'll note that the title of this post is a question, rather than a statement. It would be immense hubris to pretend that I had uncovered something on the order of importance of the original Three Jewels. Nonetheless, I think it's a useful framework. We should seek to anchor ourselves through Enlightened Investors (Buddha), a valid Investing Philosophy (Dharma), and an Investing Community (Sangha).Enlightened InvestorsValue-oriented investors generally view Benjamin Graham,Warren Buffett and Charlie Munger as the Holy Trinity of sorts of value investing. These three are considered the greats partially because of their status as pioneers and successful exponents, and partially because they have been so generous in sharing their philosophy with others. Luminaries such as T. Rowe Price have left a much smaller footprint on which to base one's learning.The extent to which this Holy Trinity has influenced investors is easily seen. One of the books I read was Guy Spier's "The Education of a Value Investor". He recounts how he found himself asking "What would Warren Buffett do in my shoes?" The motivational speaker Tony Robbins calls this "modeling" our heroes. While Spier may seem extreme, going so far as to install a bronze bust of Charlier Munger in his office, he remarks how Winston Churchill's office at Chartwell was similarly decorated with reminders of people he admired, such as Napoleon, Admiral Nelson and Jan Smuts. The practice served Spier well in the 2008 financial crisis, as he studied "heroes of mine who had successfully handled adversity, then [imagined] that they were by my side so that I could model their attitudes and behavior." Naturally, we may have to reach into the past to find these true masters. The ever witty Charlie Munger notes that mimicking successful people works equally well "if you go through life making friends with the eminent dead who had the right ideas."Investing PhilosophyI wrote an initial post about Buffett a few weeks ago outlining his philosophy as seen through the lens of his investor letters. I highly recommend Spier's book for more on his understanding of a value philosophy. Similarly, two of the other books I read, Mohnish Pabrai's "The Dhandho Investor" and Fred Martin's "Benjamin Graham and the Power of Growth Stocks", offer fresh perspectives on the Graham-Buffett-Munger investing style. Reflecting his debt to others, Pabrai says, "I have very few original ideas. Virtually everything has been lifted from somewhere." This is, however, extremely modest of him. While the philosophy may not be new, he comes up with inventive ways to view the challenge of investing, showing that there are different ways to express a broad philosophy. Investing CommunitySpier is by far the most explicit about the importance of developing an appropriate investing community. He states "we have to be extraordinarily careful to choose the right environment - to work with, and even socialize with, the right people. Ideally, we should stick close to people who are better than us so that we can become more like them." He believes that "creating the right environment or network helps tilt the playing subtly the right direction so that you become far more likely to succeed."He also goes on to cite several quotes from Buffett emphasizing this principle:- "The key to life is figuring out who to be the batboy for."- "Hang out with people better than you, and you cannot help but improve."- "Nothing, nothing at all, matters as much as bringing the right people into your life. They will teach you everything you need to know."

Finally, Spier is fulsome in his praise of his friend Pabrai, and it is apparent that they have both reaped the benefits of an investing community.

But It's Not All Perfect

While this is a useful framework, I have some reservations. For example, which comes first, the Enlightened Investor or the Investment Philosophy? In other words, do we consider an investor Enlightened because we agree with his philosophy? Or do we start first with the Investor, and then trust in the investing lessons he imparts? It may be a case of "when the student is ready, the teacher will appear", to quote Spier. But I'm inclined to believe that the philosophy comes first. It's also important to note that while we may look to Enlightened Investors as models, our styles will ultimately differ due to our inherent abilities and temperament. Spier recognizes this: "As investors, we all have shortcomings; as I came to see it, the key is to accept who we are, understand our differences and limitations, and figure out ways to work around them." He believes Buffett's "strength comes in part from this rock-solid sense of who he really is and how he wants to live." "Instead of trying to compete with Buffett, I should focus on the real opportunity, which is to become the best version of Guy Spier that I can be." This is something I can empathize with. Early in my career, I was often overwhelmed by the breadth of knowledge my various PMs had. Seeking to mimic them accentuated my natural tendency to be a dilettante ("[fluttering] all ways, and [flying] in none", to quote Philip Wakem in George Eliot's "The Mill On The Floss"). I have had to consciously accept that it is better to develop smaller pockets of knowledge, and to grow the number of these pockets over time.Philosophy?Finding the jewel of a valid investment philosophy isn't always straightforward. I was struck by how Pabrai's ethos of "Few Bets, Big Bets, Infrequent Bets" differs from much of academic finance, which generally preaches diversification and often seeks to reap small, frequent premia. This is complicated by the fact that there are many variations to a broad philosophy. Pabrai seems willing to bet on much more cyclical and leveraged businesses than most Buffett adherents. Even more unusually, Fred Martin's book positions Graham as a growth investor rather than a traditional value investor, relying on Graham's 1962 edition of Security Analysis, which, for whatever reason, appears to be have fallen out of favour with the value camp.

Deciding on a valid philosophy is a big part of the journey. However, we must be wary of letting a philosophy ossify into dogma. As Spier notes "part of what makes Warren himself so successful is that he's never stopped seeking to improve himself and that he continues to be a learning machine."Community?Identifying a community of like-minded investors is clearly an important part of the Three Jewels. However, as noted above, the group's philosophy can become rigid. Herding is also a genuine problem. Sometimes the group's beliefs can have little to do with the group's core philosophy (in several earlier posts - here and here - I've puzzled over why value investors routinely seem to be Fed-bashers). Avoiding herding is particularly important in investing. As Pabrai notes, "value investing is fundamentally contrarian in nature", so it would be antithetical to fall in line with groupthink. Referring to his contemporary Walter Schloss, Buffett wryly noted, "I don't seem to have very much influence on Walter. That's one of his strengths: no one has much influence on him."Another issue is becoming resistant to sources of truth external to our chosen community. Wisdom and knowledge appear in the oddest places, and true learners are open to these opportunities. Investor Sanjay Bakshi recalls how he ignored the investment advice of a high school dropout, but later realized the man was an outstanding investor. In a more humourous riff on this (but no less important to Manchester United fans!), former manager Sir Alex Ferguson recently revealed that he signed club legend Eric Cantona after hearing his players Gary Pallister and Steve Bruce rave about the challenge of facing Cantona. Nothing exceptional about that, you might say - except for the location of the conversation. "I was in the bath with the players, which was highly unusual for me." A generation of Manchester United fans can be grateful for Ferguson's attention to sources of truth, even when in the bath!The One Perfect ReligionThe concerns I've raised apply to any pursuit of truth - investing, politics, or religion. I am reminded of the words of poet Elizabeth Alexander:We crave radiance in this austere world,light in the spiritual darkness.Learning is the one perfect religion,its path correct, narrow, certain, straight.The Three Jewels of Investing are a useful starting framework. But no framework is perfect. The only answer is to continue learning (as the greats do), and to surround oneself with people who are intellectually curious and honest. My guess is that this is the key to improved investment results, but more importantly, continued intellectual growth.